GLD and Gold's Selloff

Gold has suffered a rough couple of months, getting pounded below major support.
One driver was stock-market capital flowing out of gold again, as evidenced
by renewed differential selling pressure seen in gold-ETF shares. But this
was minor compared to last year's, despite extreme bearish sentiment plaguing
gold. Gold-ETF selling exhaustion has effectively been hit, paving the way
for big rebound buying.

The dominant gold ETF remains the American SPDR Gold Shares, which trades
as GLD. This vehicle revolutionized gold trading for stock investors,
creating a quick and efficient conduit for the vast pools of stock capital
to migrate into and out of gold. And since GLD just celebrated its 10th
birthday this week, it's a great time to take another look at it. Starting
from humble beginnings, GLD has matured into a gold juggernaut.

If you weren't following the precious-metals realm back in the early 2000s,
it's hard to even imagine how different the pre-gold-ETF era was. Before GLD's
introduction in mid-November 2004 kicked it off, stock traders had no easy
way to prudently diversify part of their portfolios into gold. Their only options
were selling stocks to buy physical gold coins, trading gold futures, or buying
gold-miner stocks as a gold proxy.

But for pure stock traders, all these posed real problems. While physical
gold is awesome, buying coins is an inefficient and expensive process
riddled with high premiums. Gold futures are a highly-leveraged and exceptionally-dangerous
game most stock traders avoid like the Black Death. Though gold stocks can
be wildly profitable, they are far riskier than gold itself due to an array
of serious operational risks.

The gold ETFs led by GLD gave stock traders a cheap and easy way to bypass
all these alternatives to gain direct gold-price exposure. GLD held physical
gold bullion in trust for its shareholders. And all it took to buy GLD
shares was a mouse click and trivial trading commissions. And even with GLD's
0.4% annual management fee, it is still far cheaper than gold coins given the
high premiums they command.

GLD was created specifically for American stock investors by the World
Gold Council, the industry group funded by the world's biggest and best gold
miners. It was never intended to replace physical gold for investors, but
to open up gold investing to stock traders who would never or could never (due
to legal restrictions like in mutual funds) buy gold coins. Despite the silly conspiracy
theories, GLD has been a great success.

And its resulting big footprint has forever altered the gold landscape. GLD
is a tracking ETF, designed to mirror the gold price. But GLD's shares
trade independently of gold, leading to constant supply-and-demand mismatches.
If they aren't immediately addressed, GLD shares will decouple from gold and
this ETF will fail its tracking mission. Literally the only way to maintain
tracking is for GLD to act as a capital conduit.

Excess supply and demand of GLD shares from stock traders has to be quickly equalized
into physical gold bullion. The mechanics of this are simple. When demand
for GLD shares exceeds gold's own, GLD will be bid up faster than gold and
decouple to the upside. GLD's custodians must step in to supply this excess
share demand. They do this by issuing new GLD shares and immediately selling
them.

The proceeds from expanding GLD's share base are then plowed directly into
physical gold bullion in a matter of hours. So excess GLD-share demand by stock
traders effectively shunts their capital directly into gold itself,
bidding it up faster and keeping GLD tracking it. Whenever GLD's gold-bullion
holdings are rising, it always means that GLD-share demand from stock traders
exceeds the demand for gold itself.

But conduit ETFs are a double-edged sword. Sometimes stock traders want out
of gold, and sell GLD shares at a faster rate than gold is being sold. This
excess GLD-share supply will hammer GLD's price below gold's and cause it to
decouple to the downside. That excess supply has to be quickly absorbed or
GLD will fail. So its custodians immediately start buying back GLD shares to
sop up the surplus offered.

They raise the capital to do this by selling some of this ETF's underlying
physical gold bullion. And that effectively pulls stock-market capital back
out of gold, weighing on its price. Stated another way, excess GLD-share selling
pressure is also shunted directly into gold itself. GLD opened up a major highway
for stock-market capital to quickly flow into and out of gold, depending on
the prevailing whims of stock traders.

When the gold miners launched GLD via their World Gold Council, they sought
to address withering criticism from hardcore physical-gold-or-die conspiracy
theorists by being hyper-transparent. Thus every single trading day,
GLD publishes an exhaustive inventory of every single gold bar it holds in
trust for its shareholders. This data includes serial numbers, refiners, weights,
and purities. This week it was 863 pages long!

Having GLD's holdings available daily is a fantastically-useful dataset, because
it effectively shows whether stock-market capital is flowing into or out of
gold. When GLD's physical-gold-bullion holdings are rising, stock traders are
buying gold on balance. And when GLD's holdings are falling, stock traders
as an aggregate are selling gold. Stock-market capital flows via GLD can greatly
affect gold's prevailing prices.

Before we dig into that, strategic context is essential. Back in September
2012, gold was trading around $1750. That's when the Federal Reserve launched
its wildly-unprecedented third
quantitative-easing campaign. QE3 involved the Fed conjuring paper money
out of thin air and using it to buy up bonds, monetizing them. Naturally
this was highly inflationary, and should have been great for gold like
QE1 and QE2 were.

But curiously, QE3's open-ended nature along with Fed jawboning about backstopping
stock markets instead fomented a monster general-stock levitation. Stock traders
believed the Fed would step up its money printing to arrest any significant
stock-market selloff. And with this effective Fed Put, they aggressively and
euphorically bought stocks while ignoring large and mounting fundamental, technical,
and sentimental risks.

As the stock markets melted up last year thanks to the Fed, demand for alternative
investments led by gold evaporated. Alternatives only shine brightly when conventional
markets are struggling. This vexing dynamic led to a massive 22.8% gold plunge
in 2013's second quarter. This happened to be the worst quarter for gold in
an astounding 93 years, an extreme once-in-a-century anomaly of epic
gold selling!

This unprecedented gold mass exodus primarily came from two fronts. First
was extreme
futures selling by American speculators, which I've written a lot about.
Second was extreme selling in GLD shares. Stock traders fled GLD at crazy rates,
forcing it to vomit vast torrents of gold supply into the global market. And
naturally heavy selling spawns a vicious circle, where lower prices drive more
selling forcing prices even lower.

As the Fed-levitated stock markets melted up, GLD's selling would increase
as the desire for alternative investments and prudent portfolio diversification
waned. Then when they pulled back periodically, the differential selling pressure
in GLD would slow dramatically. The inverse relationship between the benchmark
stock-market levels and GLD's holdings is
striking. And so was GLD's impact on gold prices.

My chart today looks at the last couple years of GLD's holdings with the gold
price superimposed on top. Since GLD's all-time-record holdings high in December
2012, all monthly draws and builds in GLD's holdings are noted. And though
GLD contributed greatly to gold's once-in-a-century selling anomaly in 2013,
in recent months its impact has been modest. This is actually a very bullish
omen for gold going forward!

Not surprisingly, GLD's holdings have a strong correlation with gold. When
stock-market capital flows into physical gold bullion via this conduit, GLD's
holdings rise and that buying pushes gold higher. But when stock traders exit
gold, their selling flowing through GLD forces this metal lower. And that's
the whole story of 2013. Extreme GLD-share differential selling spawned by
the Fed's stock-market levitation crushed gold.

The World Gold Council does the best research into global gold supply and
demand. According to its latest numbers, gold demand dropped 11.1% in 2013
to 4081 metric tons. That was 509t less than 2012's. But the largest gold-demand
categories of jewelry and physical bars and coins actually grew dramatically last
year, up 18.0% and 32.0% respectively. Only one category shrunk, and that was
gold ETFs.

Gold demand through ETFs swung from 279t in 2012 to an astounding and probably
never-repeatable negative 880t! Differential gold-ETF-share selling
in 2013 added 880 tonnes of gold supply to the world markets, far more than
that 509t total drop in global demand! So truly without the mass exodus of
stock traders from gold ETFs, gold's price would have actually risen last
year instead of plunging by 27.9%!

And of that epic global gold-ETF selling, America's GLD alone accounted for
553t or 5/8ths of the total. GLD is the dominant gold ETF by far, and can really
impact the gold price when there are heavy supply-and-demand mismatches with
its shares necessitating gold-bullion buying and selling. GLD's holdings liquidation
alone in 2013 exceeded the total drop in world gold demand, so it's effectively
solely responsible!

That epic outlying record draw was radically unprecedented. Remember that
gold ETFs were only first introduced in late 2004, and GLD's
periodic draws before 2013's extreme anomaly were vastly smaller. So the
gold world had never before witnessed American stock traders pulling capital
out of this precious metal en masse. Such an event was never even possible
before in history before gold ETFs arrived.

While GLD's epic draws last year were spread across every month of 2013, the
second quarter was the epicenter. That quarter alone GLD's holdings plummeted
by 252t, or over 45% of 2013's total. April 2013 alone, that month gold suffered a
panic-like plunge when major support failed, saw a crazy 142.7t draw! That
represented over a quarter of last year's total GLD liquidations, the
pinnacle of popular fear.

The inevitable selling exhaustion was finally hit in January 2014, following
a mind-boggling 41.7% draw in GLD's holdings of 564t over 13.2 months. Selling
is always finite, there are only so many stock traders who own GLD and are
susceptible to being scared into selling low. Thus GLD's holdings stabilized
this year, despite the Fed's vexing ongoing stock-market levitation. They
started grinding sideways.

Until the last couple of months that is. After seeing modest GLD holdings'
builds in February, March, June, and July, differential selling pressure resumed
in September and October. The remaining stock traders owning GLD, the strong
hands that weathered 2013's extreme anomaly, were getting scared by gold's
steep selloff. This metal slumped to support in September, and then broke that
key support last month.

While it's never wise to sell into extreme lows, we can't blame the stock
traders for capitulating on gold given the extreme bearishness in recent months.
As a full-time speculator, investor, researcher, and newsletter writer, I'm
as deeply immersed in the precious-metals realm as anyone. And to me it sure
felt like the recent gold bearishness even exceeded that of the spring of 2013
and the end of last year.

In fact fear had grown so crazy-high that gold stocks were recently pummeled
to apocalyptic levels.
The leading gold-stock index, the HUI, just fell to fundamentally-absurd 11.3-year
lows! The last time gold stocks had traded so low, gold was merely $350.
But earlier this month it was around $1150, or 3.3x higher. Gold-stock levels
are a reflection of gold sentiment, and hadn't been worse for over a
decade.

So the universal fear infecting gold in the last couple months was the most
extreme seen at least since its secular bull was born in April 2001. If there
was ever an event to drive everyone wavering out of GLD shares, gold's recent
$1190 support break was it. Yet despite this the differential selling pressure
on GLD shares remained modest. September and October only saw relatively-minor
GLD draws of 25.1t and 28.7t.

For comparison, in 2013 GLD's monthly draws averaged 46.0t! So the
recent GLD-share selling was almost trivial relative to that epic extreme.
Between mid-July and early November, gold's price dropped 14.7% over 3.9 months.
In that entire span, GLD's holdings merely fell by 67.2t. There were multiple
single months in 2013 that saw comparable or larger draws. GLD hasn't been
a major factor in gold's recent selloff!

So why was gold so weak then if American stock traders weren't to blame? Extreme
selling by American futures speculators. Every week, their total gold-futures
positions are revealed in the Commitments of Traders reports from the CFTC.
And in the CoT-week span that most closely matches that recent gold drop, these
guys dumped 36.6k long-side contracts while adding a breathtaking 74.1k short-side
ones!

Some perspective is essential on these extreme numbers. Specs slashed their
gold-futures longs by 14.8% in that short span, while ramping their shorts
by 90.6%. Both moves resulted in heavy gold selling, at a total of 110.7k gold-futures
contracts. This is the equivalent of a jaw-dropping 344.3 metric tons of gold
supply unleased by American futures speculators alone! Obviously that dwarfs
the 67.2t contributed by GLD.

Extreme
futures shortingis the best kind of selling, as every single
one of those contracts will soon have to be unwound. Speculators effectively
borrow gold to sell it short in dangerous highly-leveraged bets, and they
legally have to rebuy that gold soon to pay it back. So the near-record gold-futures
shorting is super-bullish for gold and portends an imminent sharp short-covering
rally. But back to our GLD focus here.

While American stock traders did capitulate as gold swooned to and through
$1190 support, they only contributed less than 1/6th of the identifiable
American gold selling. And that was in the most extreme fear-laden and hyper-bearish
gold environment seen in over a decade! The modest differential selling pressure
on GLD shares in light of this reinforces that selling exhaustion has
effectively been reached.

Selling low is dumb, there's no polite way to sugarcoat it. Smart investors
and speculators buy low and sell high, and refuse to succumb to popular
fear to do the opposite. GLD's remaining shareholders are far stronger and
smarter than the crop that abandoned gold last year. Their holdings are far
more sticky, more likely to be permanent portfolio diversification rather than
hot money spookable into fleeing on a whim.

Last week GLD's holdings slumped to 720.6 tonnes, a 6.1-year low! The last
time they were down here was September 2008, heading into that once-in-a-century
stock panic. And gold was trading around $900. So theoretically ignoring
churn, the remaining GLD shareholders are likely still sitting on nice gains
in gold. Since they've held on this long, they are highly unlikely to join
today's irrational fear-blinded selling.

And if this proves true, GLD's holdings have finally decisively bottomed and
can only go higher. That will necessitate new stock-market capital inflows
into gold via GLD. And the catalyst for stock traders returning to alternative
investments led by gold will be these vexing Fed-levitated stock markets finally
decisively rolling over very soon here. With gold so incredibly loathed, there
is vast room for GLD buying.

As of its recent holdings low, GLD was worth about $27b. That same day, the
total market capitalization of the elite S&P 500 stocks was $19,030b. If
only 1% of that stock-market capital would diversify into gold, GLD's holdings
would soar by 7.1x! That equates to enough stock capital flowing into
GLD to force its custodians to buy about 4400t of gold at today's cheap prices.
And 1% is really conservative in the grand scheme.

For decades if not centuries, the most prudent portfolio-construction wisdom
advocated all investors holding 5% to 10% of their investable capital in gold
for diversification and insurance. So seeing an overall 1% US allocation to
gold as the stock markets roll over into what's almost certain to be a
new cyclical bear is a conservative projection. Alternative investments
shine the brightest when conventional ones are weak.

At Zeal we've always been contrarians, buying low when few others will so
we can later sell high when everyone is euphoric and multiply our fortunes.
Given the extremes in gold and the Fed-levitated stock markets today, it's
probably never been more important to cultivate a studied contrarian perspective.
It is essential to help you protect and grow your capital when these overextended
markets inevitably reverse.

We publish acclaimed weekly and monthly subscription
newsletters that help speculators and investors like you do that. They draw
on our decades of hard-won experience, knowledge, wisdom, and ongoing research
to explain what's going on in the markets, why, and how to trade them with
specific stocks. Subscribe today with
big market changes afoot! And if you are interested in gold stocks, which are
going to skyrocket as gold mean reverts far higher, we publish comprehensive
reports profiling the elites with the best fundamentals. Buy
yours today and get deployed early before fortunes are won!

The bottom line is the recent gold selloff was not primarily driven by American
stock traders dumping their GLD shares. Though they did capitulate a bit, the
great majority of the selling came from American futures speculators making
leveraged downside bets on gold. The fact that stock traders largely held strong
in the most bearish gold environment in at least a decade is a very bullish
portent for gold prices.

With GLD's holdings so incredibly low, there's vast room for major stock-trader
buying as gold inevitably recovers. As the Fed-manipulated stock-market melt-up
starts cracking soon, investment demand for gold among American investors and
speculators is going to soar. And the torrents of capital that will flow back
into GLD shares will be shunted directly into underlying physical bullion,
catapulting gold higher.

If you have questions I would be more than happy to address
them through my private consulting business. Please visit www.zealllc.com/financial.htm for
more information.

Thoughts, comments, flames, letter-bombs? Fire away at zelotes@zealllc.com.
Due to my staggering and perpetually increasing e-mail load, I regret that
I am not able to respond to comments personally. I WILL read all messages though,
and really appreciate your feedback!

Mr. Hamilton, a private investor and contrarian analyst,
publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis
of markets, geopolitics, economics, finance, and investing delivered from an
explicitly pro-free market and laissez faire perspective. Please visit www.ZealLLC.com for
more information, www.zealllc.com/samples.htm for a free sample, and www.zealllc.com/subscribe.htm to
subscribe.